V4 Energy Cooperation

18.01.2016
|
By
John Szabó

Introduction

The turmoil erupting in Ukraine early this year, has spurred the European Commission (EC) to pay accentuated attention to the energy-supply security. This caution primarily stems from the looming threat of natural gas supply disruptions, as was the case in 2006 and 2009 during the political conflicts arising between Russia and Ukraine. Although, these occurrences were strong push factors in the development of the European natural gas market, the potential threat at hand must not be underestimated. Energy packages, which include directives focusing on developing the natural gas market, have been published by the EC, as early as 1998 (Directive 98/30/EC), followed by Directive 2003/55/EC and 2009/73/EC. However, the nature of directives, as opposed to, for example, regulations has led to sluggish implementation of measures amongst EU members. (Boersma et al. 2014)

The Visegrad Group (V4) members have set a good example, not only in developing their domestic energy markets, but also in strengthening regional cooperation and liberalizing their gas markets. Regardless of these actions, further measures still need to be implemented, because most CEE(1) countries are still vulnerable to the direct impact of supply disruptions through Ukraine.

Through this paper, I wish to examine and point out how the situation of the V4 countries stands in terms of natural gas supplies, imports and market structure. Following independent examination, I will attempt to assess the cooperation of these countries, both in hindsight and based upon future projects and strategies.

Literature

The literature I have used mainly comprises databases, existing studies, as well as reports. My primary source of statistical information was (BP 2013), (Eurostat 2014) and (IEA 2014b), through which I could understand the V4 countries’ natural gas markets.

The International Energy Agency’s (IEA) country specific reports concerning The Czech Republic (IEA 2010), Hungary (IEA 2011a), Poland (IEA 2011b) and the Slovak Republic (IEA 2012a) provided me with a direct access to in-depth analysis’ of the energy sectors in the given countries. Directives and recommendations: (European Parliament & Council of the European Union 2003) and (EC 2014a), along with the reports published by Gazprom: (Gazprom 2014a) or (Gazprom 2014c), allowed me to grasp the fundamentals of the EU’s and Russia’s approach to the natural gas market. Additionally, a few recently published studies, e.g. (Boersma et al. 2014), were available due to the relevance of my chosen topic.

Energy consumption in the V4 countries

Certain similarities, such as a large role of fossil fuels and the importance of nuclear energy in three of four V4 countries, can be identified in the structure of V4 members’ TPES(2). Natural gas role varies amongst V4 states, with its portion in the energy-mix being the lowest in Poland, 13.88% in 2012, whilst the highest in Hungary, reaching 35.27%. (Eurostat 2014) A relatively low level of domestic natural gas production is a common feature of V4 states, resulting in high-dependency upon imports. (BP 2014)

Natural gas in the Czech Republic

Gross inland consumption of energy in the Czech Republic is heavily reliant on the use of its domestically produced coal and lignite, with their role in TPES reaching 40.38% in 2012. (Eurostat 2014) The use of such environmentally unfriendly fuels goes against EU objectives to reduce emissions, therefore: “The Czech Ministry of Industry and Trade (MPO) is planning to build three additional reactor units … nuclear energy would account for 30-35% of the domestic energy mix by 2040, an increase from current levels, which are at 16%. The share of solid fuels would drop from 40% to 12-17%.” (Jirous 2014, p. 4) Natural gas role would also gradually increase from its current share of 16.03%, to 20% of TPES by 2030, and 22% by 2050. (BP 2014) (IEA 2010)

As the Czech Republic is a landlocked country, natural gas is transported there via pipelines; it has two main suppliers: historically Russia, and after signing the deal to diversify imports – Norway. The deal struck in 1997 ensured the delivery of gas for 20 years. Generally, Norway supplies virtual gas, swapped for Russian gas delivered through German pipelines. However, it was proved during the supply crisis in 2009 that physical gas imports were also possible from Norway. (Kalan 2013)

In 2013, total imports amounted to 11 bcm(3), of which 7.2 bcm (65.45%) originated from Russia, whilst 3.8 bcm (32.54%) from Norway. (BP 2014) Importation is executed through the Yamal-Europe and the Nord Stream/OPAL/Gazelle pipeline systems. (IEA 2010) The latter has helped eliminate the high-risks of transit disruptions through Ukraine and has cemented the country’s transit role by supplying gas to southern Germany and France, and possibly to Slovakia and the CEE region in the future. Importation of Russian gas is conducted through a long-term contract signed in 1998 and running through 2035. (Gazprom 2014a) The Czech Republic has one of the largest natural gas storage capacities in the region, with 10 facilities capable of storing a total of 3.2 bcm. (Kalan 2013)

Natural gas in Hungary

The consumption of natural gas in Hungary amounted to 8.6 bcm in 2013, which was 37.75% of TPES. Consumption has shown a declining trend in recent years and according to the estimates of the government domestic consumption will stabilize between 8-9 bcm/a(4). (IEA 2011a) As domestic production is relatively low (approximately 2 bcm/a), dependency on imports is high, with Russian supplies amounting to 5.9 bcm (68.6% of total gas consumption) in 2013. (Eurostat 2014) (BP 2014)

Hungary’s cooperation with Russia regarding the importation of natural gas began in 1975, with the sales of Russian gas currently being exclusively managed by Panrusgas Gas Trading Plc. Gas is delivered through pipelines via Ukraine and Austria and is based on a long-term contract signed in 1996. This agreement will expire in 2015. (Gazprom 2014a) Hungary has one of the largest storage capacities in the region totaling 4.4 bcm. (IEA 2011a)

Natural gas in Poland

Poland, as the largest economy by GDP of the V4, also consumes the most energy. TPES reached 97 974.4 TOE in 2012, of which a large portion (51.58%) was generated with the use of solid fuels. Petroleum products are the second most important source of energy in the country, whilst natural gas is third. (Eurostat 2014) Consumption of the latter amounted to 16.7 bcm in 2013, and with domestic production only reaching 4.2 bcm, the economy is heavily reliant on imports. It imported 11.4 bcm in 2013, of which 9.6 bcm originated from Russia, whilst the remaining 1.8 bcm from European countries other than the Netherlands, Norway and the UK. (BP 2014) Gas consumption within the country is projected to increase by 28% between 2009-2020 and 52% by 2030. (IEA 2011b)

Poland is the oldest buyer of Russian gas, with importation dating back to 1944. All major effective contracts were signed with PGNiG(5), of which the largest contract, 10.25 bcm/a will be effective until 2022. The role of Poland as a transit country is also of key importance, with transit volumes flowing through the Yamal/Europe-pipeline reaching 28 bcm/a. Because of this, negotiations linked to the aforementioned supply-contract with Russia in 2009 were overseen by the EC. As a result, the destination clause was scrapped and flows and reverse-flows between Germany and Poland were enabled. (Gazprom 2014a)

An important step to diversify Poland’s imports was the commitment to build the Swinoujscie LNG terminal, with a regasification capacity of 5 bcm/a by the end of 2014 and potential for expansion to 7.5 bcm/a until 2017.

Poland was the center of attention in 2010, when the US Energy Information Administration (EIA) published that the domestic shale gas reserves may amount to as much as 5.3 tcm(6), securing approximately 300 years’ domestic demand. However, following a second locally conducted reservoir assessment, estimates were drastically cut to about 1/10th of the original figure. Numerous foreign, mostly North American companies have looked to participate in extraction. “But difficult geology, inadequate regulations and an uncertain tax regime have all put paid to the vision, setting back Poland’s shale-gas hopes. Investors now shy away.” (H. R. 2014) Regardless, Poland is still projected to be amongst the first European countries to produce shale gas. (IEA 2013)

Natural gas in Slovakia

Slovakia’s gross inland consumption in 2013 amounted to 16.6 MtOE, of which the largest portion was produced with the use of natural gas (29.52%), whilst coal (18.67%), oil (21.08%) and nuclear (21.69%) also play major roles in TPES. Domestic production of natural gas is nearly non-existent, 0.2 bcm in 2012 (IEA 2014b), thus the economy has been heavily reliant on Russian imports, with 2013 figures reaching 5.3 bcm. (BP 2014)

The Brotherhood pipeline running through Slovakia is of key importance in transiting Russian gas to Western Europe. Its full capacity amounts to 90 bcm/a; however its utilization varies. Between August 2013 and July 2014 gas flows from Ukraine to Slovakia totaled 47.57 bcm (52.86%). Utilization of the pipeline was higher prior to the construction of Nord Stream(7), which plays a substantial role in supplying the German market, e.g. in 2009 66.4 bcm, nearly 40% more natural gas entered Slovakia via this route. (IEA 2014b) (IEA 2012a) Slovakia’s storage capacities amount to 3.36 bcm, with a maximum withdrawal rate of 45.11 mcm(8)/day. (Pozagas 2014) (Nafta 2014)

The region as a whole

An overview of the V4 countries as a homogenous entity reveals that the total primary energy consumption amounted to 178.8 MtOE, of which 35.2 MtOE (19.69%) was produced with the use of natural gas. However, Poland was the only country with significant domestic production (3.8 MtOE in 2013), showing just how import-dependent the V4 countries are. Additionally, each country is highly reliant on a single source, namely the Russian Federation. The V4’s total imports of natural gas from Russia amounted to 25.2 MtOE – an import dependency of approximately 66.07%. (BP 2014)

Three pipelines deliver Russian gas to the region, thus transport-related risks can be significantly reduced if the individual markets are integrated into one complex entity.

Utilization of pipelines in the V4 region

Country

Pipeline

Flows between September 2013 – August 2014

Maximum capacity / a

Utilization rate

SK

Brotherhood pipeline

44.84 bcm

100 bcm

44.84%

HU

Brotherhood pipeline

6.47 bcm

20.59 bcm(9)

31.42%

PL

Yamal-Europe

33.83 bcm

33 bcm

Approx. 100%

PL

Nord Stream

31.418 bcm

55 bcm

57.12%

Source: (IEA 2014b)

These rates show that utilization of existing routes, except the Yamal-Europe pipeline, are low when compared to the maximum capacity and therefore supply disruptions can be managed by the modification of import routes. In a such scenario, transport costs would likely drive prices higher.

A new route of diversification – South Stream – has also been planned, to deliver Russian natural gas to CEE. The project itself is highly contested by the EC, due to compliance issues with the Third Energy Package. However, the affected countries do not all agree with the EC’s standpoint, emphasizing that although it is not a much-needed alternative source for natural gas, it does increase supply security. By eliminating risks stemming from transit through Ukraine, it would primarily benefit Hungary and Slovakia of the V4 states. The project itself has raised a heated debate due to the high-level of political controversy rooted in the EU’s goal to decrease Russian influence. The economic sanctions imposed in mid-2014 by the EU members upon Russia, have also postponed the beginning of construction. At this point, it is difficult to forecast any certainties regarding the South Stream pipeline. (Gazprom 2014d) (Chyong 2011) (Paltsev 2014) (Deák 2012)

LNG must not be overlooked as an important supplementary import source for the V4 region. The completion of Poland’s LNG terminal will help increase energy security and will also function as a point of leverage for all V4 members when long-term contracts are re-negotiated with Russia. (EC 2013) Moreover, the completion of the First Phase of Croatia’s LNG terminal on the island of Krk, will add an extra capacity of 1-2 bcm/a, which will gradually increase to 6 bcm/a with the implementation of the project’s third phase (EC 2014b) this, with the planned reverse flow completed by 2015 from Croatia to Hungary, will also enable additional LNG to enter the V4 market. (10) (Boersma et al. 2014)

Interconnectivity

In the European context the V4 countries have made a tremendous progress in the integration of their natural gas networks. The Czech Republic “essentially became part of the German natural gas market” (Boersma et al. 2014, p. 6). Furthermore, it is connected with both Austria and Slovakia. A project not yet completed, upgrades its interconnection with Poland, creating a Poland-Czech flow, which would allow it to receive the natural gas from the Yamal pipeline via a much shorter route than Germany, in a case of supply disruptions in Ukraine.

Vast improvements have also been made by Poland in providing the flow from and to Germany. (Boersma et al. 2014) An important issue is the creation of the North-South Corridor, which will ensure both domestic and international transits of natural gas. This project is intertwined with the construction of interconnectors between Poland and Slovakia, as well as Slovakia and Hungary,(11) which will greatly improve the integration of the V4 gas market.

Hungary has also taken great measures to develop an integrated market in the region, and is now connected with most of its neighbors, except Slovenia.

A pipeline with a capacity of 8 bcm/a, connecting the Constanta LNG terminal to HU

?

HU/SI

HU – SI interconnector

interconnector between HU – SI.

2018

PL

The North-South Corridor in Western Poland

–

2016-2020

PL

The North-South Corridor in Eastern Poland

–

2015-2020

PL/DE

The upgrade of PL – DE

Interconnection in Lasów

Planned capacity: 2,3 bcm/a

2015

PL/SK

PL – SK interconnection

(North-South Corridor)

A link between PL – SK

Technical capacity: min 6 bcm/a.

2017

SK/HU

SK – HU Gas Pipeline Interconnector

A new interconnection between the gas systems of SK – HU.

2015

(EC 2014b)

Stress test 2014

As a response to the ongoing military intervention in eastern Ukraine, the EC decided to conduct a stress test amongst Member States to model the potential effects of supply disruptions. Multiple scenarios were examined, with the rate of cooperation, severity of supply-cuts and winter conditions being the key variables. The outcomes, in case of colder-than-average winter and cooperation between EU countries, showed that of the V4 countries Hungary and Poland would have to face disruptions in supplies ranging between 20%-60% of demand, with the Czech Republic and Slovakia only being moderately affected (<10%). The high level of storages in Member States is a sign of well preparedness; with only Hungarian and Portuguese storage facilities filled lower than 80% of their maximum intake. However, Hungary’s larger-than-average storage capacities, when compared to consumption, show that the country is well prepared for potential disruptions.

Supply disruptions would lead to the quick depletion of storage capacities, thus other measures must also be mapped out. Whilst LNG would help subdue effects, it would generate a sharp rise in prices(12). An increase in prices would result in the prompt switch to alternative fuels in approximately 10% of the market. If disruptions were to continue, market conditions would then force other players to follow. As a last resort, authorities will have to implement non-market-based measures to protect some consumers.

Currently the time necessary for non-market-based intervention varies amongst countries – in the 6-month supply disruption scenario between September 2014 and February 2015, the Czech Republic would take measures in mid-October, Hungary in early-January and Poland, as well as Slovakia in late-November. (EC 2014a)

Conclusions

V4 Member States have been, and will remain to be, vulnerable to energy-supply disruptions in the near future. The prominent role of natural gas in TPES, paired with the low domestic production has led to strong import-dependency, which, due to the lack of alternative energy sources, leaves Russia as the primary regional supplier.

Led by national initiatives and backed by regional cooperation and the EC, developments have been achieved since the 2006 and 2009 events. The Czech system has essentially become an organic part of the German market. Slovakia, because of its important transit role, has been slightly less vulnerable to disruptions. Hungary has constructed interconnectors with neighboring countries, which is a huge leap forward in developing an integrated market and Poland has focused on constructing its LNG terminal, as well as developing reverse-flows from Germany. All measures are vitally important, however actions must still be implemented, desirably at a faster pace. The PCI’s must be constructed to achieve a fully integrated market, whilst regional cooperation must also be prioritized, as opposed to the developments on a national level. (EC 2014a)

V4 cooperation has helped subduing the risks related to dependency, however the region is far from being fully interconnected. Further actions are necessary and they must be backed by political motivation. The aforementioned developments have helped each state on a national level; however, to achieve real interconnectivity, the North-South Corridor must be constructed and the HU-SK interconnector must be put to use without further delay. This would strengthen the V4’s integration with the western European market and it would also allow LNG to be both a form of security during in case of disruptions and a form of leverage against the non-market-based pricing of Russian gas.

Sources

Boersma, T. et al., 2014. Business As Usual European Gas Market Functioning in Times of Turmoil and Increasing Import Dependence. Available at: http://www.brookings.edu/~/media/Research/Files/Papers/2014/10/european%20gas%20market%20import%20dependence/business_as_usual_final_2.pdf [Accessed October 15, 2014].

Chyong, C.K., 2011. The Economics of the South Stream pipeline in the context of Russo-Ukrainian gas bargaining. Available at: http://www.usaee.org/usaee2011/best/chyong.pdf [Accessed October 31, 2014].

EC, 2014a. Communication from the Commission to the European Parliament and the Council on the short term resilience of the European gas system, European Commission. Available at: http://ec.europa.eu/energy/doc/energystresstests_communication.pdf [Accessed October 23, 2014].

EC, 2014b. Projects of Common interest. Available at: http://ec.europa.eu/energy/infrastructure/pci/pci_en.htm [Accessed October 17, 2014].

European Parliament & Council of the European Union, 2003. Directive 2003/55/EC of the European Parliament and of the Council of 26 June 2003 concerning the common rules for the internal market in natural gas and repealing Directive 98/30/EC. Available at: http://eur-lex.europa.eu/legal-content/EN/ALL/?uri=CELEX:32003L0055 [Accessed September 30, 2014].

Jirous, F., 2014. Assessment of climate change policies in the context of the European Semester Country Report: Czech Republic, Ecologic Institute. Available at: http://ec.europa.eu/clima/policies/g-gas/progress/docs/cz_2014_en.pdf [Accessed October 9, 2014].

Kalan, D., 2013. Window to the West: The importance of the Czech Natural Gas market for V4. The Polish Institute of International Affairs, (No. 25), p.2.

9 Calculations are based on (IEA 2014b), which register max flow in Mcm/h. Mcm/h*24*365 = bcm/a, however in reality capacities of the mentioned pipelines somewhat differ, due to maintenance, energy used for transports etc.

10 Croatia’s consumption of gas is relatively small (2.68 bcm in 2012), therefore a large portion of LNG can be exported to neighboring countries.

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